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Responsible Banking Ordinance: The Only Way Out

Posted in Finance Articles, Total Reads: 2776 , Published on December 27, 2012

Micro finance Institutions in India are striving hard for survival, not only due to the recent issues of repayment, but also due to the new regulations passed by the Government of India. The Government has appointed the Central Bank of Country as a regulatory body to keep a check on these institutions. Therefore, there is a need for the industry to redefine its objectives and re-frame its strategies in order to survive in a highly- regulated environment. Accordingly, this report suggests some reform strategies that the regulators need to adopt to continue to deal with micro-credit and financial distribution in for the betterment of the poor. In spite of all these problems investors are keen on investing in MFI, provided high scrutiny measures are introduced and the original objectives of serving the society's needy and the deserving people are met.


Emergence of Micro Finance in India

Microfinance came as a replacement to the informal forms of dearer credit to the poor who otherwise didn’t have access to funds to source their business and for their social and economic upliftment. This was not only an effective credit option but also a very powerful instrument to eradicate poverty in economically backward countries. Micro Finance Institutions find their roots in indigenous self-help groups that came into existence in 1980, formed with a purpose to fund their needs in a micro manner. Gradually, big commercial institutions like NABARD and SIDBI stepped in, thereby giving wing to the concept of micro financing.

This industry grew thick and fast; perhaps a bit too soon. It soon found itself in the eye of the storm that uprooted the lucrative micro-financing industry in Andhra Pradesh, when unscrupulous politicians influenced borrowers to default on a mass scale, resulting in a staggering liability of unpaid loans, to the tune of USD 1.5 billion. The state that once boasted a 2 billion dollar micro-loan industry, today finds itself at the centre of a crisis that has churned the world of micro finance.

Problem in Andhra Pradesh

Some of India's poorest people have become hapless victims of MFIs loan charge. The crisis has tarnished the widely praised acclaimed reputation of micro lenders who give lend to the poorer sections of society, with the hope of making them be self sufficient. However, villagers claim that agents from various MFIs offer enticing loans schemes, with scant regard for any previous pending loans. Their goal is to merely increase volume to attract big investors. New commercial companies have given loans up to 7 billion $ in the past decade alone, thereby attracting a lot of investors. Companies like SKS finance raised 1650cr through an IPO.

Such profit-seeking micro lenders in states like Andhra Pradesh have thus abandoned their social responsibilities which was once an integral part of the Micro Finance Model pioneered by Muhammad Yunus.

Micro finance companies that were created with the objective of developing the rural areas and uplifting the poorer sections of the society, ironically, ended up worsening their economic situation. To shall the deterioration, the government passed an ordinance to regulate the micro finance institutions and put in stringent measure to control the flow of credit to the poor.


This paper has four objectives: First is to look at the present state of MFI in India with regards to the impact on millions of poor families in Andhra Pradesh. Secondly, why reforms are needed for MFIs, in a country like India. Third is developing a regulatory framework for microfinance in India. And lastly to recommend the strategies that the MFIs need to implement in order to survive and also a course of actions for policymakers.

Why we need reforms??

Success and failure are part of the game. Though there have been some success stories in micro-financing from around the globe that have evidently benefited the poor through a variety of programs, there are few instances of failures too. Not only has microfinance proved to be an adequate aid to resolve the monetary problems of the people, but has also provided some broader social benefits like creating gender equality and improved health.

Despite its glowing side of the success of these MFIs, there are some reasons for the ongoing microfinance system which needs to be regulated. The reasons for regulating MFIs can be improving the self-sustainability of these institutes, safeguarding the system from financial instability, protecting the savings of the depositors, prevention of money laundering or even to the height of funding for terrorism. (B. Seth McNew, 2009)

Developing a Regulatory Framework for Microfinance in India

The Microfinance Institutions (Development and Regulation) Bill, 2012 puts the RBI firmly in control of the sector.

Therefore off late a trend to register MFIs as companies has started in India. Some have registered as non-profit organizations under Section 25 of the Companies Act, to take advantage of the RBIs exemption from registration for such companies rendering microfinance services. Of the 1,000+ MFIs in the country, perhaps 400-500 continue to function in the form of registered trusts according to M-Cril’s estimate for the number of MFIs.

Having learnt from the past problems and challenges that the MFIs face, there is a need to create principle based regulations focusing on:

  • Ensure consumer interest by keeping a check on
    • Credit Limit
    • Monthly Payments
    • Outlay aggressive collection practices
    • Clear interest rate disclosure
  • Monitoring and supervising the credit flow through the MFI in order to make the system more transparent.
  • RBI measures on interest rates are too stringent which may limit the idea of developing new and innovative products so make few laws which are in favour.
  • Making it mandatory for all MFIs to register.
  • The MFI should give more time to borrowers to become debt free.
  • There should be a system of a loan card containing effective interest rate, all information, and terms and conditions
  • Interest rate should be properly displayed on MFIs website.
  • Credit Bureaus need to be established and all MFI must mandatorily be a part of such Bureaus.
  • There should be some prescribed capital adequacy ratio maintained by MFI.

One of the top concerns in India is, regardless of the fact that the central government has introduced the bill, and the RBI, which is given a firm control over MFIs, has come up with the new regulatory framework banks have not started lending leading to the continuing liquidity crisis. So, one of the essential primary reforms is that banks need to start lending again to MFIs. Secondly, equity needs to come back for banks to start lending. And lastly return normalcy in Andhra Pradesh, which requires a huge political will.

Another gray area that we need to focus on is microfinance banks or small finance banks to safeguard small depositor’s interests. Because of RBI’s conservatism policy which does not permit anybody except banks to accept savings deposits, the problem is that access to these institutions is limited. It is a good idea because it ensures that people’s deposits are safe and in well-regulated institutions; however, even today, majority of the people do not have access to bank accounts which is why these people are forced to take up unconventional schemes. Therefore we need RBI to ease up on the concept of microfinance banks or small finance banks and ensure that the deposit is guaranteed through insurance so that the depositors’ money is safe.

In an interview to India Knowledge @Wharton, Mr.Vijay Mahajan, the president of the MFI Network of India and also the founder and chairman of the Basix social enterprise, said, "In a nation that wants FDI investments and seeks to upgrade its economic laws, for the whole financial system to just stand by and allow this kind of vandalism -- US$ 1.5 billion of loans, which were performing for 15 years, were allowed to be converted into an unofficial waiver is simply unacceptable. The government put nine million of its own citizens into a state of default. Today, no one is standing up from the financial sector to say this is wrong. Tomorrow, the politicians could do the same thing to larger financial institutions." (Vijay Mahajan, 2012`)

Since it is a newly regulated industry, one must concentrate on the needs of the savings and loans sector; so that the regulatory frameworks are strengthened at all times to seek protection to the sector and boost its development. However, few important issues that need to be addressed in the short term are:

  • Improving the definition of microcredit, according to the activities for which they are intended (considering loan sizes, terms, source of payment, etc.);
  • Establishment of Mobile Financial Operations;
  • Recognizing the role that MFI could have on financial inclusion requires new regulation that promotes new business models;
  • Improve Corporate Governance Practice.

Rebirth of Micro Finance in India: The only way out

If India is eradicate poverty, we need to improve the overall standard of the poor people in India by bringing in Financial Inclusion reforms. The only way out is to resolve the issues faced by MFI in India, be it the issue of unfair debt collection or high interest rates by bringing regulations that protect both MFIs and  borrower’s interests.

Microfinance in India has come on par with death. As Hindu Philosophy says that the soul never dies and it’s the body which perishes, the same philosophy can be applied to microfinance which as a soul can survive the crisis and will find a new abode. So there is a need to re-define the steps being taken for re-birth of microfinance which will help it to come out of its draconian death.

  • Dignifying the need of financial services and financial systems

One of the important issues in microfinance is the way microfinance is seen as micro credit. So there is a need to bring in a whole range of financial services which the MFIs can deliver to the poor people. A proper financial system will help to deliver these services and not just throw it like micro credit. Though there are some challenges like making the people understand the financial products but then too with will comes the way.

  • Long term structuring of loans

Loan repayment structuring is an important tool for the loan to not default. If the MFI wants to decrease the chances of default of a loan, they should primarily focus on the repayment structure. It should not be such that the installments have to be paid every week, as was the case in AP. The loan should be structured as per the capacity and capability of the consumer.

  • Pro-active role for maintaining their sustainability

Commercialization thought by MFIs pushed them to non-sustainability of their business. Incorporating profit- making as their primary objective; microfinance themselves have sent an invitation of non-sustainability which becomes a problem in microfinance which threatens the road ahead of these institutes. So the MFIs should distinguish between maximum profit and normal profit for the liveliness of their business.

  • Consolidation

In saturated markets the MFIs should go for consolidation which will help them to curb the problems of liquidity. Another benefit of consolidation is attraction of capital investors by mean of merge pool assets and provide the MFIs economies of scale and reduce their operating expenses.


The Microfinance Bill passed by the government has significant potential towards restoring the trustworthiness in the Indian microfinance sector. Despite the increased participation of commercial banks, the SHG-bank linkage programme reaches only about one-third of potential borrowers and one-tenth of the estimated demand for credit.  Therefore alternate agencies like the MFI who intend to serve the poor are very much needed. Many MFIs in the country have come up with an idea of community-based institutions. While the commercial banks are made more accountable in terms of meeting the credit needs of the poor, MFIs need to be encouraged to emerge as supplementary channels.

If the government works with the same amount of commitment for achieving financial inclusion then India's image can transform in days to come.

This article has been authored by Darshak Shah & Rupesh Shah from Durgadevi Saraf Institute of Management Studies

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